The present invention relates to analytical systems and methods used by financial advisors and individual investors. More specifically, the present invention pertains to systems and methods for valuing and comparing variable annuity products and associated guaranteed living benefit rider features.
Historically, variable annuity products have been sold as tax sheltered mutual fund type investments that gave the owner the option to annuitize, i.e. convert a lump sum account value into a fixed (typically) stream of payments that would (typically) last until the death of the owner or last joint owner.
More recently, innovative optional contract add-ons known as guaranteed living benefit (GLB) riders were introduced. These GLBs are now the primary driver of sales of variable annuity products. A popular type of GLB rider, known as a Guaranteed Lifetime Withdrawal Benefit (GLWB), is elected by a high percentage of annuity customers who are offered the option.
There are four general types of guaranteed living benefit riders: (1) Guaranteed Lifetime Withdrawal Benefits (GLWB) which provides a guaranteed minimum benefit that is accessed through withdrawals and is active for as long as the owner (joint owner) is alive; (2) Guaranteed Minimum Accumulation Benefits (GMAB), which provides a guaranteed minimum benefit that is paid out as a lump sum at the end of a deferral period; Guaranteed Minimum Income Benefit (GMIB) that provides a guaranteed minimum benefit that is accessed when the owner annuitizes, typically at pre-set annuitization rates; and (4) Guaranteed Minimum Withdrawal Benefit (GMWB) in which a guaranteed minimum benefit is accessed through withdrawals and terminates when the benefit balance reaches zero.
While each type of GLB rider is different, a concept common to each is that they offer the owner a guaranteed floor on their equity investment. Therefore, the guaranteed “benefit base” will never decline in value, regardless of how underlying sub-account assets (e.g. mutual fund type assets) perform, further assuming that the contract rules are not breached. The two most popular types of GLBs (GLWB, GMIB) also offer a longevity guarantee which allows the owner to withdraw a certain amount of money from the contract each year for as long as they are alive. This guarantee applies regardless of the value of underlying assets (even if they go to zero, again assuming that the owner follows the rules of the contract).
To increase market share, some variable annuity companies have innovated other features to differentiate their GLB riders from competitors. These GLB rider features can generally be classified as Deferral Bonuses, Benefit Base Ratchets, Guaranteed Withdrawal Amount Ratchets, Benefit Base Roll-ups, and Income Storage.
These features essentially implement different mechanisms to increase the guaranteed floor, thus increasing the guaranteed income payout. However, each variable annuity company has its own rules and restrictions on how these features work. Therefore, it becomes very challenging to compare the value propositions of the competing products.
FIG. 1 illustrates shows how the performance of a variable annuity is typically presented in a conventional prospectus. The graph in FIG. 1 is reproduced from page 94 of a MetLife® Preference Plus Select® variable annuity prospectus dated May 1, 2009, the content of which is incorporated herein by reference.
FIG. 1 shows how the guaranteed “annual benefit payments” 104, “cumulative withdrawals” 106, and “account balance” 108 of this variable annuity with a guaranteed lifetime withdrawal benefit might vary over time. The terms used in FIG. 1 may be proprietary to this product are not necessarily industry standard terminology.
The graph in FIG. 1 assumes that the variable annuity initially has $100,000 in its account at year 0 and that the account balance earns a static, deterministic rate of return. In this illustration, it is further assumed that the owner elects to begin taking withdrawals immediately. Under this scenario, the annuity rider provides guaranteed annual benefits payments of $5,000 per year to the annuitant (e.g. person who purchases the annuity), which stays constant over time.
If the annuitant lives for 20 years after purchase (e.g. age 85 if the annuity is purchased at age 65), then a total of $100,000 in cumulative withdrawals will be paid. If the annuitant lives longer, then more will be paid but if the annuitant lives for a shorter period, then less will be paid in the form of a guaranteed living benefit.
Each year, the amount of the account balance is decreased by the amount of the annual benefit payment plus fees that the insurance company charges. The fees are charged to cover the costs (including profit) of managing the account and of providing account guarantees. Over time, the amount that an annuitant may electively withdraw outside of the guaranteed annual benefits decreases. The ability of the annuitant to withdraw a guaranteed annual benefit each year while the annuitant is alive, regardless of the value of the account balance running to zero, is referred to as a “guaranteed living benefit.”
The amount of money that the annuitant may electively withdraw may be decreased by a “surrender charge”. Surrender charges may be significant in the first few years of an annuity and may decrease thereafter.
The annuity may also allow the annuitant to specify a beneficiary to whom at least a portion of the account balance might be paid if the annuitant dies before the account balance goes to zero. This is referred to as a Guaranteed Minimum Death Benefit (GMDB). A GMDB may function in a manner similar to the living benefit, because it guarantees a minimum payout, regardless of market performance, with mechanisms to increase over time. However, the payout is contingent on the death of the contract owner.
The account balance may be invested according to the direction of the annuitant but subject to terms and conditions of the annuity. Thus, the account balance may increase or decrease depending upon the performance of the investment.
There are costs associated with providing different features in an annuity. These costs are reflected in fees which vary with the features selected by the annuitant.
A full description of the terms and conditions associated with a variable annuity are described in a prospectus. While all of the information that describes most variable annuity products is publicly available in detailed prospectus literature, it is extremely difficult and time consuming to understand the product details. There are several reasons for this. First, a prospectus may be written by one or more lawyers, and therefore uses language that is difficult for a financial advisor and individual investor to understand. Second, there is no industry-standard vocabulary to describe the common and generic features of these products. Instead, each company uses its own vocabulary when describing its products in both its prospectus and other marketing literature. This adds to the confusion and frustration when a person tries to compare competing products and the basic language used to describe the common features of the products are different. Third, a typical prospectus is lengthy. The terms and conditions may be very complex and require hundreds of pages to describe.
The difficulty in comparing different variable annuities is further compounded by the large number of funds in which the annuitant may invest his/her account balance. For example, FIG. 2 lists a portion of the funds available for a typical MetLife annuity along with descriptions of investment objectives of each fund. FIG. 3 illustrates how these funds have performed historically along with the different fees associated with each fund.
To properly understand the value proposition for different variable annuities and their GLB riders, a number of components must be considered, and understood how they can change over time. These components include Total Fees, Cash Surrender Value, Benefit Base, Guaranteed Withdrawal Amount, Investment Options and Restrictions, Death Benefit, Issuing Company Financial Strength, and Product Flexibility & Restrictions
Referring again to the graph in FIG. 1, much information about the product is not conveyed. A static graph as shown cannot illustrate how the account value might change under different economic scenarios. This can have a significant impact on a purchasing decision.
Annuity product information that is publicly available is not sufficient for answering the fundamental question: Which product offers the best value for an investor, given their unique circumstances? There are several important flaws in relying on just the published product information.
First, variable annuity products are dynamic in nature. Because of the many interconnected variables, it is a mistake to attempt to determine the best product for an individual by looking at a description of features and separately evaluating each individual component. Rather, it is necessary to evaluation the product as a whole.
Second, simply comparing product features is not appropriate in determining the best value for a given investor, as this incorrectly implies a static, one size fits all approach. In reality, the value proposition of a given annuity product is relative to the prospective owner and his/her unique circumstances. The individual parameters and circumstances that may need to be considered include demographic characteristics (e.g. age, sex, health, spouse), owner preferences (investment allocation, low fees vs. richer guaranteed floors, bequest motive) and owner behavior (when to begin withdrawal, when to annuitize, decision to lapse).
Third, the relative value of one product over another ultimately depends on the scenario path played out. A “scenario” is how the investments will perform in the future. While the exact scenario is unknown when purchased, product descriptions would not provide adequate information on how competing products would fair under different scenarios.
Another problem lies in how one could reduce the universe of variable annuity products with certain features into a short list and then study and compare these products in more detailed format. This leads to situations where advisors make this decision based on reasons that are not necessarily in the best interest of their clients, such as their personal relationship with the insurance company wholesalers, soft incentives, as well as which companies pay the highest commissions.
Thus, there is a need for an effective way to understand the value proposition and compare different variable annuities. More specifically, there is a clear need for a dynamic product comparison and decision making engine—a tool which considers the unique circumstances of the investor, models the competing products in a consistent framework that captures all of the key dynamics of the products, and illustrates the output in a easy to understand format and dynamic.